Level 2 Trading Explained for Beginners

This subscription-based service shows bid prices and sizes along the left side of the display screen while at the same time displaying ask prices and sizes along the right.

Furthermore, it can give you a better idea of the types of investors and traders who are purchasing or selling a particular stock as well as the direction in which that stock will most likely head in the short-term. The following content will help you understand what Level 2 trading is, how it functions, and why it can help beginning stock traders better understand the open in a specific stock.

What exactly is Level 2 Trading?

According to Investopedia, Level 2 trading is basically “the order book for NASDAQ stocks.” Stock orders are typically placed through numerous market makers and participants. Level 2 displays the best ask and bid prices from all participants, thereby providing you with detailed insight into a stock’s movement and price. It can be very useful when you know what stocks investors and traders are interested in, especially when you’re just getting started in day trading. Here’s an example of a Level 2 quote:

per share. (NOTE: shares of stock are displayed in hundreds – 50 x 100 = 5,000)

Who are the Players?

When it comes down to day trading in the financial markets, the major participants or players in the stock markets are categorized in 3 groups as follows:

• ECN’s or electronic communication networks – computerized order placement systems that enable you to trade in the stock markets, even the career investors or larger, institutional traders.

• MM’s or market makers – this group of individuals provide liquidity to the market. They are required to purchase stocks when no one else is and sell them when no one else is. They literally make the market, hence the category name.

• Order flow firms or wholesalers – it’s not uncommon to see online stock brokers selling their orders to wholesalers. These are referred to as “order flow firms” and will execute orders on the broker’s or retail trader’s behalf.

Additionally, each market participant or player is identified by a 4-letter ID that typically appears within the body of the quote. For example, DBAB is Deutsche Bank Alex Brown, FBCO is Credit Suisse First Boston, GSCO is Goldman Sachs, JPHQ is JPMorgan, NMRA is Nomura Securities, and UBSW is UBS Securities.

What is “the Ax?”

The market maker controlling a given stock’s price movements and clearly the most important one of all is known as “the Ax.” If you spend a few days watching Level 2 trading action, you’ll be able to identify which market maker this is. This is the market maker that consistently dominates stock price actions and is used by numerous day traders because it provides them with a higher probability of succeeding when they are day trading securities and stocks.

Why should You consider using Level 2 Trading?

If you want to know what’s happening with a particular stock, using Level 2 price quotes can tell you quite a bit. Here are 4 reasons to consider using Level 32 Trading:

• Level 2 trading will point out irregularities and tell you when the major players are trying to keep their stock purchases under wraps.

• Level 2 trading will tell you what type of stock trading is transpiring.

• Level 2 trading will tell you when stronger price trends are ending by looking for activity that’s taking place between the bid and ask price.

• Level 2 trading with the Ax will tell you when the price is trending, thereby increasing your chances of trading successfully.

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